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The Real Estate Philosopher


Distressed Debt Acquisitions? Not So Fast…

May 24, 2020

I will start with Warren Buffett.  To paraphrase one of his famous quotes:

When your underlying business isn't doing that well, it hardly makes sense to buy into a new business that you know nothing about
 
Yet exactly that is happening right now through much of the real estate world's rush to buy distressed debt. 

Let me start with some background…

Ninety days ago, you had a large number of parties in the real estate world, all with different core competencies and areas of expertise.  Many had that critical component for success; namely, the ability to "create value" in a real estate transaction.  I wrote an article on this point about ten months ago, where I pointed out that:

            "You Will Never Find a Good Deal Again"

My point was that anyone could "find" a deal, and it hardly leverages your skills or talents to look at the same stuff everyone else is looking at – and do you really think you can outperform on a long-term basis when you are looking at the same screen that everyone else is seeing at the same time. 

Instead, I made the point that your "real" job is to "create" good deals.  And that is the key to long-term outperformance.  This article had more positive responses than almost any article I wrote since so many agreed with that essential truth.

Now I see so many doing the exact opposite, and the place they are focusing on is "Distressed Debt."

There was, I think, about $600B of "dry powder" anecdotally lying around before COVID-19, and I don't know how much new money has been raised for "Distressed Debt." I'll guess another $100B.

For you math majors out there, this is about $700B of dry powder, a large percentage of which, whatever it was originally raised for, is now targeting distressed real estate debt.  And there now seems to be a view that the distressed debt players will roam the plains scooping up Distressed Debt at fire sale prices from desperate debt sellers.

Sorry – I don't see this happening, and even if it does to some degree only the true distressed debt players will profit in a meaningful sense. 

Instead, what will undoubtedly happen is that only a very few holders of debt will end up being "forced sellers," and most of that will be played out quickly.  As for the rest, the pricing will, with incredible rapidity, be bid up to "market" by the $700B of dry powder. 
 
In this vein, my sense is that even if someone is a forced seller, they are hardly going to go hat in hand to a single party providing dry powder to buy Distressed Debt.  No, this party will go to a broker and many players, some of whom are very inexperienced in the subtleties of buying distressed debt, will have the chance to bid on that debt until it gets to a point where someone is either paying market or more likely overpaying.  The concept of a "bargain" is not going to happen, at least not most of the time.

Indeed, those moments where cash is truly king only last for a short period, and I think the time is either over already or will be soon.

If you think I am just making all this up, consider our Distressed Real Estate Win/Win Hub that we announced about 30 days ago.  So far, many very legitimate real estate players have contacted us.  Of those, the vast majority have (a lot of) "dry powder" and are "open for business."  And almost all of them expressed eagerness to acquire distressed debt. 

As water seeks its level, capital for distressed debt will do the same and with incredible speed. 

So what is my advice to the real estate world?

If you are already an expert in distressed debt, then this is great.  Those players whose skill set is truly in the acquisition of distressed debt (mostly the big players that do this for a living in all markets) should continue doing this because this is where they will indeed create value through Distressed Debt acquisitions.  I predict that you will find some solid opportunities, but I bet not as much as you are hoping for.  Also, you will have to pounce earlier than you like is my guess before the bidding gets too strong.
 
All those parties who are now going into the Distressed Business because they think it is some newfangled way to make a killing will either overpay or find they just wasted a lot of time on frolic and detour.  I mean, if you are a great developer, do you really think you are going to just snap your fingers, raise a distressed debt fund, out-compete the players who have been doing this for many years, and have all the contacts and expertise?  If so, who would give you money for this business?

Indeed, if you are not already an expert in distressed debt, it is hard to imagine a worse moment to go into it than right now.  Most ironically on this point, "development" is now a four-letter word; accordingly, what better time to acquire property for development at depressed prices?    So if, by way of example, you were a developer before the pandemic, I urge you to stick with your day job where you can ‘create value' and continue creating it because this leverages your talents and skills most effectively, whereas going into the distressed debt business does the opposite and pretty much negates your skills to compete in a game where others hold the edge. 
 
I have three very important asides here:
 
First, please don't read this article as saying there will not be a lot of distressed debt around or opportunities therein.  There may indeed be a lot of it here or coming.  My point is that  those with expertise in that business – or that can bring enormous capital to bear – will have a major advantage over all the new players charging in to change their business models to buying distressed debt.
 
Second, if you aren’t a distressed debt player; maybe you are a developer and you understand real estate.  And you see a deal in trouble that you have a particular roadmap for, then of course you should figure out how to work on it, perhaps even teamed up with a distressed debt expert player.  There can be great opportunities here and this could indeed be a way for you to “create” value. 
 
Third, what I hope is obvious, is that whoever you are, the best place to find a distressed debt deal is in regard to property you already own.  However, I don’t really call that a distressed debt acquisition; instead the term of art is really a “DPO.”

I will end by quoting the same article I wrote ten months ago, and say:

"You Will Never Find a Good Deal Again"

You will still have to "create" those deals and, if you are not already an expert in the distressed debt acquisition space, plunging in at this time is very unlikely to be a way for you to drive long-term outperformance.

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As the Chairman of Duval & Stachenfeld – a law firm in mid-town NYC known as The Pure Play in Real Estate Law – I am inviting you to join The Real Estate Philosopher™. This will consist of my thoughts and also thoughts of friends and colleagues.

It will not be published in any traditional media – it will go only to friends of our firm. The purpose here is very simple – to put forth thoughts in the real estate world that are different, provocative, and challenging of accepted wisdom. Hopefully, nothing said here will be mainstream thinking.

You may be wondering how I am qualified to write on these topics since I am “just” a lawyer. However, I have an unusual place in the real estate world. As the Chairman of The Pure Play in Real Estate Law (one of the largest real estate law practices in NYC), I interact with an incredible number of real estate players. This ranges from small real estate shops with nothing but a gleam in their eyes, to some of the largest real estate institutions in the world, and everything in between. This gives me a unique and global perspective and allows me to act as an amateur philosopher in the real estate world. This has always been my hobby and it is what I love doing.

Regards,

Bruce Stachenfeld
a.k.a The Real Estate Philosopher™

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